Incentive Measures For Each Stage Of Business

by admin

Incentive Measures For Each Stage Of Business

by admin

by admin

How can companies tell if they have selected the best measures for Executive and employee incentive plans? In this article, we discuss examples of effective performance metrics for incentive plans based on different stages of company growth. 

As we tiptoe towards 2022, news of mixed corporate success continues, including stories of growth companies that have rewarded investors with outsized gains for taking on significant risk over time  (cue mining and tech sectors!). Yet even in these growth sectors, very few start-ups / explorers become the next mega market cap industry dominator.

What factors account for the difference in progress? What has driven performance for those very successful growth companies?

No doubt there are a multitude of factors such as innovative systems and processes, however in most cases, it is management’s ability to execute the business strategy.

Then the question is – what incentive measures have encouraged management’s behaviours to deliver the strategy? What incentives sustain a working environment and culture that realises sustainable shareholder value throughout the various stages of company growth?

A few years ago, we ran an analysis across ASX300 companies to understand differences in incentive practices between the best performers and worst performers based on total shareholder return. The findings (see TRP research report – ASX300) provided an insight into a number of interesting characteristics of high performing companies. These include a higher propensity to focus on operational excellence measures for short term incentives and capital efficiency for long term incentives.

What we also found was that whilst there was no magic formula for metric selection, there is commonality in the groups of measures that correlate with higher shareholder return i.e., earnings and profit measures often featured for high performing companies.

How metrics should adapt to all stages of the business cycle

Whilst our ASX300 research provided an insight into incentive plan approaches adopted by high performing companies, particularly in a growth phase, a broader consideration is how metrics should adapt to all stages of the business cycle.

For example, early stage development companies in ‘cash burn’ will initially focus their incentive programs on R&D / exploration activities and some revenue targets which ultimately translates into share price growth. For maturing companies, the focus of metrics align with consistently generating double digit earnings growth, encouraging accretive earning per share (EPS) through smart acquisitions and/or strong capital management.

The following tables provide a more detailed look at some incentive metric themes across three business cycles, along with a few examples of company approaches from our work with clients.

 

Business phase – Start-up

Typical feature Focus on getting the business up and running. Revenue/market value starts to pick up.
Business focus
  • R&D
  • Enhance brand identity
  • Formalise processes
  • Generate revenue
Implications on incentive measures
  • Financial measures: Revenue, cash flow management
  • Non-financial measures: projects, product development, attraction of investors/customers
Example measures 
  • Short-term (~12 months): achieve product commercialisation of XX units, customer growth of X%, achieve revenue target $XX
  • Long-term (~3 years): delivery of key project milestones, absolute share price growth X% / enterprise value $XX

 

Business phase – Growth

Typical feature Experiencing high growth in revenue/market value and workforce. Proactively delivering growth agenda.
Business focus
  • Grow revenue/profit
  • Stakeholder management
  • Accelerate management capability
Implications on incentive measures
  • Financial measures: Revenue/profit growth, EPS, shareholder return
  • Non-financial measures: Staff engagement, process efficiency and quality of product and service, ESG
Example measures 
  • Short-term (~12 months): achieve NPAT of $XX, Net promoter score target XX, individual performance scorecard (financial / non-financial)
  • Long-term (~3 years): Enterprise value growth / TSR growth, EPS growth, delivery of projects

 

Business phase – Mature

Typical feature Exhibiting slow/steady revenue/market value growth. May acquire businesses or become a M&A target for others.
Business focus
  • Maintain business stability (consistent growth)
  • Cost management
  • Efficiency improvements, ESG
Implications on incentive measures
  • Financial measures: Revenue/profit, capital / shareholder return, cost management
  • Non-financial measures: Innovation, digital capability, process efficiency and quality of product and service
Example measures 
  • Short-term: Profit/earnings (EBITDA, NPAT), ESG, cost management and delivery of strategic growth
  • Long-term (~3 years): Enterprise value growth / TSR growth, return on capital, EPS growth, ESG, achieve strategic milestones (innovation / new product)

Where a company currently sits within the business cycle is a critical consideration when selecting performance metrics for incentive plans, however other factors can also play a role. This rings true for public companies subject to the pressures and influences from investor groups and proxy advisors which flow through to incentive design and performance metrics. An example of such a metric is total shareholder return (TSR), which is favoured by most investor groups when it comes to LTI plans, regardless of the business cycle.

Whilst the research and market trends provide some food for thought on deriving measures, ultimately the most effective incentive design is the approach that motivates participants to deliver organisational value over the short and long term.

 

The Reward Practice is an Australian independent remuneration advisory service for Executives, Boards and Management.

Contact us for more information on designing incentive plans for ROI.

 

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